|Oregon State Bar Bulletin JANUARY 2008|
Assessing Partnership Candidates
with Concerns about the Economy
By H. Edward Wesemann
We are approaching that time of the year when large law firms consider candidates for partnership. Typically, there is a great deal of discussion and chest thumping about the standards for partnership, and committees will be formed to scrutinize the quality of associates to determine whether they have the right stuff. Within the partnership there will be advocates of quantitative standards of business development that should be required, and others will talk about the firm’s culture of honoring those associates who, having labored in the vineyards for seven or eight years, have earned the right to be a partner. The resonant question raised about the eligible associates is this: Are they good enough to be partners?
The issue may be more complex than whether associates are good enough. Over the past couple of years we have heard rumblings from managing partners that there is a chronic shortage of legal work. Despite large investments in marketing programs and business development directors, many firms simply cannot generate the volume of business to keep their lawyers busy. And, a question in the back of the minds of many managing partners as they consider new partners is whether it’s feasible to generate enough work to justify their position as a partner in the firm.
This year may be a little tougher than most. Large law firms have become accustomed to a healthy annual growth in almost every form of success measurement they look at. Since the AmLaw 100 expanded to the AmLaw 200 seven years ago, the total revenues of the top 200 firms has doubled to $65.2 billion. Revenue-per-lawyer is up 48 percent ($445,000 for 1999 to $658,000 for 2006) and profit-per-equity-partner has risen 70 percent from an average of $530,000 to $898,000. The total number of lawyers in AmLaw 200 firms has increased from 68,000 to more than 96,000. It is, therefore, hard for us to envision anything approaching a period of retrenchment. But a great deal of evidence seems to point to the very distinct possibility that a decline, or at least a significant slow down, in the growth of the U.S. legal market may be ahead.
Chief among the concerns is the litigation practice. Litigation is an economic engine that drives many firms with long and predictable revenue streams. And, after the tech boom faded, many firms converted from a traditional 50/50 split between corporate and litigation to a bigger litigation base. But most firms are seeing a decline in large case litigation. For many AmLaw 200 firms the decline is in the form of the failure of larger firms to refer cases. The larger firms’ level of work has also declined, and they prefer to hang on to matters in order to provide work for their own lawyers. For some firms, the effects of tort reform are starting to show as there are fewer cases available. And there seems to be unwillingness by general counsel to go to trial on any but the most important matters. Many firms’ litigation department chairs are reconsidering the "downstream" products liability and personal injury insurance cases they worked so diligently to get rid of a few years ago, in order to keep their people busy.
On the corporate side, the availability of work is much more elastic to the economy and concerns about the ripple effects of the sub prime mortgage market are viewed by some as an anchor that could bring down the economy. Many law firms’ corporate departments saw a slow-down in the volume of merger and acquisition ("M&A") transactions long before the recent concerns and sudden stock market slide. The monthly total value of deals announced since August is down 50 percent from any prior month this year. Worse still, law firms are fighting to hang on to a bubble of announced deals in the last year that have not closed. A serious downturn would remove a lot of work from corporate plates in the fourth quarter (not to mention the loss of much of the time already invested).
And many firms in second-tier cities face the systemic problem that much of their public company work has been lost through corporate consolidation and clients’ movement of sophisticated work to larger firms in capital market cities. Large transactional firms are telling us that they began to hold on to deals which they normally would not have handled. And this effect will also trickle down through the market. Looking at the M&A slow-down five years ago shows that the dominant corporate firms were able to expand their grip on the market when the economy recovered. It is the second tier corporate practices and regional firms that take the biggest hit.
Changing the Question
As firms consider these market influences, they may find that the appropriate question may not be whether there is a shortage of work; rather, is there a surplus of lawyers? That is, the real strategic issue is not where to find more work to keep lawyers busy, but whether the number of lawyers in the firm should be adjusted to fit the amount of work available.
This is not a new concept. In prior slow downs, most notably the 2001 tech sector market decline, many firms laid off associates to cut expenses in order to maintain partner profitability despite lower revenues. But, if you recall, we sort of promised ourselves that we wouldn’t do that again. In retrospect, many firms found that they cast off their future brightest and best to preserve partners, some of whom would probably not have passed the "are they good enough to be partners" test that the firms use today.
But one significant detail has changed over the past few years. Firms have embraced the position of non-equity partner, in many cases as a means of improving their reported profits per partner. In fact, while the total number of lawyers in AmLaw 200 firms has increased from 68,000 to 96,000 (a 40 percent increase) the number of non-equity partners in those firms has increased from 4,654 to 12,236 (up 160 percent).
In the late 1970s the Pittsburgh Pirates had a shortstop named Mario Mendoza. Mendoza’s claim to fame was that he consistently had the lowest batting average in the National League, some years as low as .189. He finished his career with a lifetime batting average of .215. Mario Mendoza is famous not for his baseball accomplishments. Instead, he is known because a sportswriter coined the term "the Mendoza Line" as the definition of how bad you can be and still play major league baseball.
The obvious question for law firms, with all of our discussion about the standards necessary to become a partner, is whether there is a standard for remaining a partner. Indeed, many law firms view themselves as a "big tent" permitting a variety of practice styles and work ethics and, under this standard, permitting partners to perform at virtually any level they see fit. This is especially true for firms that have used wholesale de-equitization to improve profitability statistics and firms who routinely make any associate who reaches a certain longevity a non-equity partner to avoid a tough decision.
It may well be that the question law firms will be debating in partnership consideration this year will not be how good you have to be to become a partner. Instead, the more significant question may be: What is our Mendoza Line; how bad can you be and remain a partner in this law firm?
ABOUT THE AUTHOR
Ed Wesemann is a management consultant working exclusively with law firms. He is a partner in Kerma Partners and limits his consulting practice to strategic, governance and growth issues. He can be reached at (912) 598-2040, or by e-mail at Ed.Wesemann@KermaPartners.com. Visit www.KermaPartners.com for more information.
© 2008 Ed Wesemann